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As a matter of a recap, rare earth
elements (or REEs) is a generic name for 17 metals widely used mostly
in high-technology devices, such as mobile phones, laptops, flat screen televisions,
hybrid car batteries, lasers, optics and military equipment. New uses for
these metals are being constantly found, but more on that later.

Despite the name, these metals are not actually rare
in nature. The name refers to the fact that they are rarely found in a pure
form and are usually mixed with other minerals, which makes extraction
complicated and costly. Further, mining and refining of rare earth metals is
environmentally challenging, due to acidic and radioactive byproducts. This
is why most countries don't produce REEs. This has led to a reduction in
reserves of these metals and left the bulk of production to less
environmentally conscious companies and jurisdictions. China has expanded its
production and, at least on the surface, looks to have a near monopoly on the
industry. According to the US Geological Survey, China possesses one-third of
the world's reserves and produces 97% of global supply.

None of this was a problem until China started
introducing trade limits. Dramatic changes took place in 2010, when Beijing
officially decided to cut export quotas on rare earths by 72%, to 35,000 tonnes, far below the levels of world consumption. Quotas
were further reduced by 35% in the first half of 2011. Steep export taxes
were applied, too. As a result, REE prices skyrocketed.

Consumers lost some of their appetite for the
now-expensive metals, and most REEs dropped in price – some of them by
as much as two-thirds. Prices remain above historical norms, however, and
were so lofty that exporters used only half of the Chinese quota allocations
last year.

It's hard to miss the steep rise in prices from
mid-2010 to April 2011. Should we expect similar price spikes in the future?
And what's the long-term trend?

Analysts have opinions supporting both bullish and
bearish outlooks. Some think another price rally is possible, since the
industries using REEs are on the rise and also because there are, in the
majority of cases, no substitutes for REEs. Neither is there an immediate
solution to the market conditions caused by China's supply policy. Others
believe that the REE market will face a surplus in 2012 and that prices will
thus correct further.

The REE market is precarious because supply is
artificially restricted. This imbalance can't be sustained for long, though,
because industries and companies that use REEs need to have predictable and
stable long-term supplies of the metals and hopefully at reasonable prices.
It thus seems reasonable to assume that the market will find ways to decrease
the effects of China's policy.

In fact, there are some adjustments already under
way in this market…

New Mines Outside China

Given the high REE prices, some previously producing
REE mines are going back into production. Molycorp
Minerals, for instance, is reopening its Mountain Pass Mine, which was shut down in 2002 because of competition
from China and environmental concerns. The company was recently permitted to
resume its operation and is expected to start producing this year. Another
recent example is Australian miner Lynas, which obtained a license to begin processing rare earths at a new facility
it's putting the finishing touches on. The company says by the middle of the
year the plant will be able to process 11,000 tonnes
of rare earths per year (about one-third of current world demand excluding
China), and will later double its capacity.

Recycling

Another solution to cope with supply shortages is
recycling. Japanese companies have been studying the technology and costs of
reusing neodymium and dysprosium from washing machines and air conditioners.
Mitsubishi Electric has made some progress by creating a device that extracts
rare earth elements from used household air conditioners. The machine "will be
installed at a factory run by Green Cycle Systems Corp., a Mitsubishi
Electric subsidiary in the city of Chiba and begin operations in April."
Another Japanese company, Shin-Etsu Chemical, announced that it will spend 2
billion yen ($US25.8 million) to build a plant in Vietnam to
process REEs from hybrid
car motors and other products. The factory is expected to open in February
2013 and will produce 1,000 tonnes of rare earths
per year.

If recycling technologies can manage to be cost
effective, they will become another source of REE supply, albeit not as
significant as new mine production.

Replacement

Another way for companies to be less dependent on
China's policy decisions is through new technology that uses less REEs. A
widely quoted example is a company called Showa Denko, which managed to
decrease its consumption of cerium oxide by half in 2011 by reusing the
material up to five times, among other technological improvements. Other
breakthroughs are likely to follow.

Relocation

China officially mined 93,800 tonnes
of REEs in 2011, only 5% more than in the previous year. Harsh export quotas
and modest growth in mine supply are considered by some analysts as the incentive "to give priority of supply to
domestic consumers and encourage foreign customers, mostly in high-tech
strategic sectors, to move their operations to China." Whether or not
they like it, the state of the current REE market may force some companies to
relocate their production facilities to China. Japanese companies Showa Denko
and Santoku, among others, have already done so.

Conclusion

It's clear that REEs have investment merit. These
elements are crucial and irreplaceable for a lot of consumer uses.

However, the REE market is small, opaque, volatile,
illiquid, and subject to manipulation. It's further complicated by a lack of
reliable data, making it difficult to forecast and risky to play. It's also
worth remembering that REEs are industrial metals, which are usually weak
when the economy enters a recession – an outcome we think is more
likely than not.